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Will the Fed Show Its Hand? - Ahead of Wall Street

While Cyprus continues to provide some background noise, the
focus today is on the Fed which concludes its two-day meeting
this afternoon. In addition to the post-meeting statement, we
will also be getting the economic forecasts of individual FOMC
members and hear from Bernanke himself in the press conference.
The issue at hand is the future of the Fed's $85 billion a month
bond-purchase program which has done more than anything else in
pushing stocks to the current all-time high levels. As such, it's
more than just an academic exercise among economists.

Recent economic data has broadly been favorable. The housing
momentum remains in place, as confirmed by Tuesday's strong
February Housing Starts and Permits numbers. The labor market
seems to be improving as well, with the weekly Jobless Claims
numbers now under the 350K level, and even the factory sector
seems to be showing signs of life again. In fact, the gains in
household buying power as a result of the improving labor market
and wealth effect from stock market and housing strength is
helping offset the negative impact from higher taxes and gasoline
prices. Last week's better than expected February Retail Sales
data prompted many analysts to raise their estimates for GDP
growth in the current and coming quarters. This improving GDP
growth backdrop has put the spotlight firmly on the Fed's QE
program.

The Fed is unlikely to announce any changes to the QE program
today, but they will likely acknowledge the improving economic
scene in the post-meeting statement as well as in the individual
forecasts. We know from the minutes of the last two FOMC meetings
that a strong group of the committee members are in favor of at
least ending the open-ended nature of the current QE program, to
give itself more flexibility to respond to changing economic
conditions. We wouldn't see any evidence of those discussions in
today's statement, but they will come out next month in this
meeting's minutes.

For now, the core of QE supporters within the FOMC, comprised of
Bernanke, Yellen, and Dudley, will hold their ground and continue
with the program. Given the expected drag on economic growth from
the budget sequester and other fiscal austerity measures, they
will be looking for at least a couple of more quarters of steady
economic growth before making changes to the program. But even
then, they are unlikely to outright stop the program. They will
most likely curtail the program at first, say from $85 billion a
month to $40 billion a month, sometime in the back half of the
year, before looking at ending it in the first half of 2014. All
of this is contingent on the current favorable economic momentum
continuing in the coming months and quarters. But as we saw in
each of the last three years when the economy lost steam in the
Spring/Summer months after positive starts earlier on, current
expectations of the economy may not pan out.

Bernanke aside, we are getting ready for the start of the first
quarter 2013 earnings season. The
FedEx
(
FDX
) report this morning doesn't inspire much confidence in what may
be in store this earnings season, but expectations have fallen
enough that we will likely see another good enough earnings
season. It's not hard to draw that conclusion from the
Adobe
(
ADBE
) and
Lennar
(
LEN
) positive surprises this morning. Overall, total earnings for
companies in the S&P 500 are expected to be down -3.9% from
the same period last year, which will compare to the +2% final
growth tally in the preceding quarter.

The expectation is that earnings growth bottoms in the current
period, starts rebounding in the second quarter, and then growth
accelerates in the back half of the year. This translates to a
+6.7% earnings growth in 2013 and an impressive +11.7% growth
next year. These positive earnings growth expectations reflect
favorable outlook for the U.S. and global economy this year and
next. The Fed appears to be skeptical of this optimistic view -
why else would they continue with the enormous $85 billion a
month bond purchase program. Perhaps we should be skeptical as
well.

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